Trading Member's Margin Shortfall With an Unreachable Client
At the close of trading, a trading member reviews a client's USD/INR June futures account. The client is long 600 lots at an average price of 83.60 (contract size USD 1,000). June futures settled today at 82.30. SPAN plus exposure margin is 4.2% of notional and is recalculated on each day's closing price. The client's ledger shows a cash balance of Rs 23.00 lakh, of which Rs 22.80 lakh was blocked as margin at yesterday's close; no other dues are pending. The member must pay its own mark-to-market and margin obligations to the clearing corporation on time regardless of what the client does. The client is travelling, unreachable by telephone, has previously disputed a square-off, and has sent no instructions. The member's compliance manual requires a documented margin call before any forced liquidation.
1. Compute the client's mark-to-market loss, the revised margin requirement, and the shortfall after MTM is debited.
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Notional at trade price: 600 x 1,000 x 83.60 = Rs 5,01,60,000.
- MTM loss = (83.60 - 82.30) x 600,000 = 1.30 x 600,000 = Rs 7,80,000. This is debited to the client's ledger in cash.
- Cash balance after MTM = 23,00,000 - 7,80,000 = Rs 15,20,000.
- Revised margin at the closing price = 4.2% x 82.30 x 600,000 = 0.042 x 4,93,80,000 = Rs 20,73,960.
- Shortfall = 20,73,960 - 15,20,000 = Rs 5,53,960, say Rs 5.54 lakh.
Margin per lot at 82.30 = 0.042 x 82,300 = Rs 3,456.60. Note the requirement fell as price fell, yet the shortfall still appeared because the MTM debit is larger than the margin reduction - this is the classic futures cash-flow squeeze for a long position in a falling market.
2. What must the member do, and how much of the position must be liquidated to restore compliance if the client does not pay?
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The member must issue a documented margin call immediately, record the attempt (including the failed contact), collect the MTM loss and the margin shortfall within the regulatory timeline (MTM losses are to be collected from the client within 24 hours, and the member cannot pass its own obligation to the clearing corporation on to the client as a defence), and if the client does not pay, square off enough of the position to eliminate the shortfall and report the default.
Lots needed to cure Rs 5,53,960 at Rs 3,456.60 per lot = 160.3, so 161 lots. Selling 161 lots releases 161 x 3,456.60 = Rs 5,56,513 of margin, leaving 439 lots with a requirement of about Rs 15,17,447 against cash of about Rs 15,20,000. Liquidation crystallises nothing extra in MTM beyond slippage, because the loss is already debited; it only stops further margin erosion. A partial square-off of 161 lots is defensible and far more proportionate than flattening the whole 600 lots, which would expose the member to a dispute over avoidable loss.
3. The client later argues he was economically hedged by an OTC forward and should not have had to fund daily MTM. How should the member respond?
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The member should explain the structural point: exchange margining is gross and cash-settled daily, contract by contract. It does not look through to an OTC forward held with a bank, even where the economics offset. The gain on the OTC forward is unrealised and sits outside the member's books; the loss on the futures is realised in cash today. That is a funding risk, not an accounting accident, and it is precisely why hedgers using futures must hold a liquidity buffer sized to a plausible adverse move.
Practical remedies to offer: keep a cash buffer of at least two to three days of expected MTM volatility; combine instruments so that part of the hedge sits in OTC forwards, which have no daily cash settlement, and part in futures, which do; reduce lot size when the underlying exposure is itself uncertain; and pre-authorise a standing instruction allowing the member to square off a stated number of lots without further contact. The lesson is that basis and cash-flow risk sit alongside price risk, and futures hedging is a cash management decision as much as a price decision.